IB Econ: Micro IA example

Course: IB Economics SL Period 7

Commentary: #1

Name: (A pretty smart kid who shall remain anonymous)

Date commentary was written: October 31, 2016

Date Article was Assessed:

The section of the syllabus to which the article relates: Microeconomics

Article Source: The Denver Post, John Ingold, July 6, 2016, http://www.denverpost.com/2016/07/06/cigarette-tax-colorado-initiative-143/

Article Title: New proposed tobacco initiative would triple cigarette taxes in Colorado

Word Count: 747

Commentary

This article is about a proposed tax in Colorado that could add an extra $1.75 to the 84 cent tax that is already on cigarettes.

Figure 1 shows that when a tax is imposed on cigarettes it creates supply curve S + tax, and the price of cigarettes increases from P to P1 due to the tax burden on consumers, and the quantity demanded for cigarettes will decrease from Q to Q1 due to the tax burden on producers. The shaded portion of the diagram represents the government revenue gained from the tax. The tax was expected to bring in 315 million dollars in the first year, which is likely due to the inelasticity of demand for cigarettes, a reason that the government might have imposed a tax on cigarettes in the first place. Figure 1 shows that the demand for cigarettes is inelastic, because the tax burden for consumers is greater than the tax burden for producers. The imbalance of tax incidence suggests that the producers will be able to pass on almost all of the tax to the consumers due to the demand for cigarettes being inelastic, which is mainly because cigarettes are addictive. However, the addictiveness of cigarettes would keep the demand for cigarettes highly inelastic in the short-term only. The elasticity for cigarettes would increase in the long-term because potential smokers would be less inclined to start smoking, and because there are close substitutes to cigarettes, such as e-cigarettes and marijuana.

Another reason that Colorado might want to tax cigarettes is that cigarettes are demerit goods, or  goods that the government sees as bad for those who consume it and for society as a whole. Cigarettes are demerit goods because they have negative externalities of consumption, as shown in figure 3. If there were no negative externalities of consumption, the MPB would equal the MSB and the market would achieve social optimum where the MSC and MSB meet. However, cigarettes have negative externalities of consumption, such as second-hand smoke, which cause the MSB to be less than the MPB. In a free market, cigarettes will be consumed at price P1 and quantity Q1, therefore the public will suffer from a negative externality of consumption. This is an example of a market failure, because a demerit good is over-provided and over-consumed. The government could have imposed an indirect tax to fix the market failure created by cigarettes. However, again the issue of substitutes arises once again, because more people may switch to substitutes of cigarettes that also have negative externalities of consumption.

Perhaps the government imposed this tax as a response to the market failure and to increase government revenue. This is a somewhat effective policy, however it is not entirely effective. Taxing cigarettes would increase government revenue because the inelasticity of demand would cause the demand of cigarettes be unaffected in the short term. Also, the government would also get closer to fixing the market failure created by the consumption of cigarettes and other tobacco products because the tax targets tobacco specifically. On paper, these reasons are legitimate and well-founded, but in reality, there are some factors that render this policy relatively ineffective. First of all, substitutes for cigarettes would be in higher demand because a shift to the left of the demand curve for cigarettes would cause a rightward shift in the demand curve for substitutes. Therefore, even if a market failure created by cigarettes is fixed, a larger market failure will be created for e-cigarettes and marijuana, which are both demerit goods and substitutes. Overall this policy wouldn’t be very effective because it would cause an increase in demand for substitute demerit goods, and would only increase government revenue in the short-term. A different policy could be much more effective, which would to be to tax nicotine, which is the addictive agent in cigarettes and in e-cigarettes, which would tax cigarettes and close substitutes of cigarettes. With the revenue gained from a nicotine tax, the government could create negative advertising towards cigarettes or educate the public about the dangers of cigarettes and other legal drugs (marijuana, e-cigarettes, etc.). This policy would have the most positive impacts because it would increase government revenue by a greater amount because the tax would target cigarettes and other substitutes (which all have relatively inelastic demand) and it would raise awareness about the negative impacts of cigarettes and other demerit goods which would ultimately come a lot close to fixing not one, but multiple market failures.

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